Russia: wide open for retail development

Virgin territory, rapidly losing its virginity. A sleeping giant, about to wake up. All typifications of the Russian food retail situation refer to its rapid development, but even more to its impressive potential.
Elsevier Food International, Vol. 6, Number 1, February 2003
Pascal Kuipers

In recent years, Moscow- and to a lesser extent St Petersburg - have been the focal point of retail development. In 2001, retail turnover increased by some 12 per cent and experts estimate the annual value of Russia's retail market to lie between US$100 and US$120 billion. The financial crisis of 1998 had a massive impact on Russian retail development. The government's stubborn budget deficits in the 1990s in combination with a poor business climate left the economy defenceless when the global financial crisis hit Russia. In those hectic days in 1998, banks collapsed and many Russians saw their savings vaporise. The government defaulted on debt and decided to devalue the rouble. All this led to a sharp devaluation in the living standard of most of the population.
Strangely enough, this crisis was a blessing in disguise for Russian retail development. In the years of recovery after 1998, Russians decided to spend instead of save their money. The financial crisis provoked a collective mistrust in the banking system and Russians did not want to run the risk of losing their savings once more. Research has revealed that Muscovites spend 94 per cent of their monthly official income, and in St Petersburg the figure is even higher: 98 per cent.

Retail infancy
According to investment bank Renaissance Capital, Russian retail turnover in 2001 reached US$102 billion (US$710 per capita). Retail turnover continued to grow in the first half of 2002, when it reached the level of US$54.2 billion and realised a year-to-year increase of 15.7 per cent. The Moscow metropolitan area has a population of 12 million (eight per cent of Russia's population) and accounted for 30 per cent of Russia's total retail turnover in 2001. Renaissance Capital expects the US$31.5 million Moscow retail market (2001) to have grown by 25 per cent in 2002.
Despite a 50 per cent increase in the number of stores in 2001, supermarkets account for only two per cent of total food sales in Russia, says Renaissance Capital, comparing Russia to Poland, where supermarkets account for 18 per cent of sales. Market researcher GfK has slightly different figures comparing Russia to Poland and the Czech Republic, but the message is the same: compared to the Central European markets, the Russian retail market is still in its infancy. Traditional sales channels like markets and small shops (kiosks) are still the most important to Russian consumers. Natasha Zagvozdina, retail analyst with Renaissance Capital explains why: "It is estimated that only 12 per cent of Russian customers shop in supermarkets and trade centres. Most people buy food and necessities in old-fashioned small shops without self service, and in markets and kiosks, primarily due to the convenience of their location. Fifty per cent of the total retail floor space in Russia belongs to outlets with an annual turnover of less than US$50,000."
In an article in the German trade publication LebensmittelZeitung (September 2002), Russian freelance journalist Sergej Kannunikov points out that large cities are still lacking in any modern retail facilities: "Novosibirsk, which has more than one million inhabitants, only has about 35 to 40 food stores with more than 500 square metres of retail space. The multiples have only two or three stores. There are only five or six self-service food stores in Irkutsk, a city of 700,000 inhabitants." Exceptions to the rule of retail infancy are Nizhny Novgorod (city of 1.35 million people) and Yekaterinburg (1.25 million inhabitants) that are, according to Kannunikov, only slightly behind Moscow's level of retail development.

Vital investment resources
The Russian capital is the country's most developed retail zone but here too traditional channels are dominant. Supermarkets account for 12 per cent of total retail sales in Moscow. This figure increased rapidly, as in 1999 supermarkets only had a four per cent share in total retail sales in the capital.
The Moscow City Government is actively involved in the further development of the capital's retail sector by supporting the construction of new trade centres and by attracting foreign investment capital for these projects. As early as 1995 it issued a decree on the gradual elimination of kiosks and three years later it issued a further decree to close 106 markets by 2004. In April 2001, the Moscow government approved its general plan for the construction of 300 shopping centres over the next 20 years. This US$3 billion investment project includes supermarkets with sales spaces of 2,000 to 10,000 square metres located along the main city roads in residential areas or as part of large trade complexes (from 10,000 to 80,000 square metres) and peripherally located trade zones (sales spaces of 130,000 to 400,000 square metres not only including retail outlets but also wholesale centres, garages, warehouses, exhibition centres and cinemas). The plan includes 20 hypermarkets with shopping areas of 15,000 to 30,000 square metres.
With hypermarkets still accounting for close to zero of total sales and a supermarket sales share of 12 per cent, there is much potential. Domestic retailers like Perekrestok, The Seventh Continent and Pyaterochka rapidly exchanged their operations in the years of recovery after the 1998 crisis. The same holds true for the foreign retail pioneer Ramstore. "The consumer retail boom in Moscow began when monthly income per capita reached the US$150 mark, which was about two years ago," says Zagvozdina in her Retail Sector Report of August 2002.
In the long term, however, access to investment capital will decide between failure and success. In this respect foreign retailers seem to be in a better position. Zagvozdina calculates that it would cost some US$700,000 to construct and equip a small-scale supermarket with 1,000 square metres of trading space, leaving aside the cost of the construction of hypermarkets and shopping malls. "The large investment resources required for retail development are not available to Russian companies," she says. "This will remain one of the most damaging constraining factors for domestic retailers in Russia over the next few years. This clearly presents a competitive advantage for foreign retail developers who, in syndicates or alone, will be able to construct or rent modern trading places, and build mega chains."

Local versus foreign
In April 2001, four leading Russian retailers with combined sales of US$550 million (Perekrestok, Kopeika, Diksi and Megamart) established the Russian Retail Alliance (RRA) to increase their purchasing clout. RRA also seeks to resist alleged favouritism by the Moscow City Government towards foreign retailers.
In March 2002, local distributors accused German retailer Metro Group of moving beyond the strict limits of cash & carry into the retail arena. The Russian Anti-Monopoly Ministry investigated Metro's pricing policy but closed the case four months later. In October 2002 -two months after opening its first hypermarket in Russia - French retailer Auchan was accused of selling certain items, especially household appliances, at a loss. According to M + M Planet Retail, Auchan rejected the allegations stating that Russian law does not prohibit selling at a loss.
"Many domestic retailers are nervous about the advent of the foreign chains," Ernst & Young's Russian office stated in a November 2001 review on the Russian market. "Their worries may turn out to be unfounded. It is likely that the best domestic chains will manage to hold onto their business, or at least sell their business at a good price."
"Faced with bustling foreign competition, Russia's leading retailers have reacted by developing a comprehensive system of alliances and establishing joint policy, expanding further into Russia's regions and investing in the modernisation of their distribution and storage networks," comments the September 2002 Bulletin of Bisnis, a US Government's resource centre for American companies exploring business opportunities in Russia and other Newly Independent States. In May 2001, Bisnis referred to some experts on the Russian retail market who attribute the 2001 boom in the opening of supermarkets in Moscow to speculative sale preparation. Russian retail chains would like to offer Western companies facilities that are ready for operation and therefore expensive.
Zagvozdina confirms this and acknowledges that Russian retailers would deny such intentions. "I base my assumption on implications that the market is giving," Zagvozdina says. "For example, Tesco visited Moscow some time ago last year and we know that in Eastern Europe Tesco already entered the market through an acquisition of a prominent domestic retailer. Another example:
Wal-Mart visiting The Seventh Continent in Moscow and getting ready to sign a confidentiality agreement under which the two companies would exchange commercial information. Finally, management of one of the Russian food retail chains was trained by Carrefour. Why would a foreign retailer not want to obtain a ready-to-use chain, with established supply chains, and western-trained management? Everything would depend on the price, in my opinion."

Foreign retailers
In 1997, Ramstore was the first foreign managed store in a western format to be opened in Russia. Ramenka - a joint venture of Turkish retailer Migros Turk (30 per cent), Enka (a Turkish construction company that owns 20 per cent) and the Turkish foreign trade company Ram (50 per cent) - manages the Ramstore chain that developed rapidly after surviving the 1998 crisis. In 2001, it almost doubled its turnover. For 2002, it targets a 20 per cent higher turnover of US$300 million. In one month (March 2002) Ramstore opened five supermarkets and by adding seven additional stores in Moscow at the end of 2002, it intends to raise its store number to 20 (three of which are hypermarkets). In 2003, Ramstore is to expand firstly to St Petersburg and then to Krasnoyarsk, Kaliningrad, Samara, Toliatly and Podolsk.
After Ramstore, it took several years before another large retailer decided to commit itself to the Russian market. In August and December 2002, French retailer Auchan opened its first two Moscow hypermarkets. This year a third outlet is to be opened. Auchan plans to invest US$300 million for the construction of ten hypermarkets in Russia.
"Currently we have three Metro Cash & Carry stores in Moscow," says Albrecht von Truchsess, spokesman of the German retailer Metro Group. "They are very successful, being well over budget. We plan further expansion in the city in the next few years. In St Petersburg, we will be opening the first store this year, and we are analysing possibilities in other large Russian cities. This year, Real hypermarkets will also be starting business in Moscow." Investing at least US$500 million, Metro Group is to open 20 Real hypermarkets in the coming three to five years.
Von Truchsess denies rumours about a possible deal with US retail giant Wal-Mart to set up a 20-store hypermarket chain under the Real banner. The Americans, however, are seriously interested in entering the Russian market. Either through a greenfield operation or via an acquisition of, or a joint venture with, a local retailer. Wal-Mart is said to have been negotiating with Bin and The Seventh Continent.
The world's most widespread franchise banner Spar has been represented in the Moscow market since December 2001, when Spar franchisee Marta (a Russian construction and retail conglomerate) opened the first store of what is to become a chain of 30 supermarkets in Moscow. In December 2001, Marta also opened a Spar supermarket in Nizhny Novgorod. Operated by Spar Middle Volga, this should become a 12-store chain by the end of 2003.